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CHAPTER ONE

1.1   BACKGROUND OF THE STUDY

        Capital budgeting is the process by which the financial manager decides whether to invest in specific capital projects or assets. In some situation, the process may entail in acquiring assets that are completely new to the firm. Other situations, it may mean replacing on existing absolete asset to maintain efficiency. During the capital budgeting process answers to the following questions are sought.

What project are good investment opportunities to the firm? from this group which assets are the most desirable to acquire?

How much should the firm invest in each of these assets?

COMPONENTS OF CAPITAL BUDGETING

Initial investment outlay: it includes the cash required to acquire the new equipment or bold the new plant less any net cash proceed from the disposal of the replaced equipment. The initial outlay also includes any additional working capital related to new equipment. Only changes that occurs at the beginning of the project are included as part of the initial investment outlay. Additional working capital needed or no longer needed in a future period is accounted for as a cash outlay or cash in flow during that period. Net cash benefits of savings from the operation.

This component is calculated as under: (The incremental change in operating revenue minus the incremental change in the operating cost= Incremental net revenue) minus (taxes) plus or minus (changes in the working capital and other adjustments)

Terminal cash flow: it includes the net cash generated from the sale of asset, tax effects from the terminal of the asset and the release of net working capital. The net present value technique, although these are several methods used in capital budgeting, the Net present value technique is more commonly used under this method a project with a positive NPV implies that at is worth investing in.

All business decisions involved a choice among alternative courses of action. The criteria for such choices may be subjective, such as attitudes of employees or the may be objective such as dollars/ Naira of cost and revenue.

Most decisions are influenced by a combination of both subjective and objective factors. In most situations, it as possible to analyze some of the consequence of alternative actions in quantitative terms and to use the result of the analysis an making a decision. If two alternative actions are under consideration, quantitative analysis will generally show which actions will lead to the higher profit or if an investment return on investment may be expressed as the ratio of income per period to the average investment for the period to the average investments for the period. Since income change either in revenue or in cost is relevant to the decision. If a decision involves a new investment that will be recovered through increased net revenue or cost savings over a period of several years, an analysis of cash flows overtime is present value computation outline of an alternative choice problem is formulated through the following steps.

  • Defined the problem and identify the alternative solution to be considered
  • Measures and compare the consequence of each alternative, in so far as these consequences can be express quantitatively.
  • Evaluate the subjective factors and considered the extent to which they offset quantitative considerations
  • Arrive at a decision

Perhaps the most common alternative choice problem involves decision for replacement of plant assets or expansion of productive facilities. The process of planning and evaluating proposals for investment in assets is called CAPITAL BUDGETING.

Capital budgeting is complicated by the fact that the decision must be made for estimate of future operating result which by their nature involve a considerable degree of uncertainty. Yet these decisions are crucial to the long-run financial health of a business enterprise. Not only are large amount of money committed for long period of time, but many capital budgeting decisions are difficult or impossible to reverse once the funds have been committed and their projects as begun. Thus companies may benefits from good capital budgeting decisions and suffer from poor ones for many years.

Many non-financial factors are considered in making capital budgeting decision e.g. many companies give high priority to creating jobs and avoiding layoffs. However  it is also essential that investments in plant assets earn a satisfactory return on the fund invested. Without this return, investors will not be able to generate sufficient funds for future investment projects.

1.2   STATEMENT OF THE PROBLEM

Financial advisers and invent managers are faced with so many problems and do not have absolute authority in discharging their responsibilities their actions are constrained by certain factors beyond their control.

There are two distinct factors which exert very string influence over budgeting decision making process individual and corporate investors carrying out their investment business in line with the legal framework and in confronting with the nations economy.

Therefore, there are internal environment which refers to internal structure of the firm and those that exists that is external environment. The internal environment addressed the inadequacy of human resources as one of the most principals factors where as the external environment includes factors such as the political economics cultural, social, legal and technological framework within which the firm operates. Capital budgeting decisions are further compounded by the high rate of inflation in Nigeria economy, the nature and size of the projects in question and decision maker is the value judgment and his skill and expertise as well as liquidity constraints.

The research shows among other things that capital budgeting techniques are very vital and important in organizational flexibility, profitability, applicability and reliability in taking decision.

1.3   AIMS AND OBJECTIVES OF THE STUDY

        The aim of this research is to under study the capital budgeting decision in manufacturing company taken vital-foam Nigeria plc, as the case study.

To achieve the above aims therefore, the following objectives will be taken into consideration.

  • To reveal the risks and uncertainty inherent proposal
  • To determine the profitability of an investment proposal
  • To determine factors affecting capital budgeting decisions
  • To reveal other quantitative factors affecting capital budgeting decisions.
  • To determine whether the investment is worthwhile undertaking or not.

 

1.4   RESEARCH QUESTION

        In the course of this research study the respondents will be able to answer to these questions.

  1. What are capital budgeting decisions?
  2. Why and how does manufacturing company get involved in capital budgeting decision?
  3. Is there a consensus in the choice of capital budgeting evaluation or appraisal techniques in manufacturing company?
  4. How do the manufacturing concerns acquire data relevant for capital budgeting decision making?
  5. What role does uncertainty play in investment decision?

1.5   RESEARCH HYPOTHESIS

        In order to arrive at logical conclusion on this research study the following hypotheses will be considered.

  1. Hi: Capital budgeting decision has no significant influence on the success of an investment outlay.

Ho:  Capital budgeting decision has significant influence on the success of an investment outlay

  1. Ho: Capital budgeting decision is not independent on the relevant data acquired

        Hi:   Capital budgeting decision is independent on the relevant data acquired

1.6   SIGNIFICANT OF THE STUDY

        It has been established that capital budgeting decision are inevitable due to their effect on effectiveness and efficiency in manufacturing company in Nigeria business. This study is attempt towards achieving its aims stakeholders will then be at an advantage to make reasonable and rational decision based on the finding conclusion and recommendations of the study.

1.7   SCOPE AND LIMITATION OF THE STUDY

        This work focuses on medium long term investment. It is in this regard phrase “capital budgeting decision we carefully chosen. Again, consideration will be limited to only select manufacturing company. It will however cover firm directly engaged in converting raw materials of any form to useable forms.

Sample Company shall be drawn from manufacturing concerns in Lagos state.

Capital budgeting decision is a top management function officers at this level may be very busy and unwilling to satisfactory complete and return the questionnaires. Other problems that would likely face during the course of this study area in the area of time. Funds and geographical distance in collecting data and information from sample and chosen manufacturing concern location.

1.8   DEFINITION OF THE TERMS

  1. Capital budgeting: Is the process of planning evaluating proposals for investment in plant assets.
  2. Discount rate: is the required rate of return used by an investors to discount future cash flows to their present value.
  3. Present value: Is the excess of the present value of there net cash flows expected from an investment over the amount to be invested. NPV is one method of ranking alternative investment opportunities.
  4. Payback period: is the length of time necessary to recover the cost of an investment through the cash flows generated by that investment. PSP is one criterion used in making capital budgeting decisions.
  5. Present value: Is the amount of money today which is consider equivalent to cash in flow or out flow expected to take place in the future. The present value of money is always less then the future amount since money on hand today can be invested to become the equivalent of a larger amount in the future.

 

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